Austerity Britain: Lesson for the U.S.?

When I was growing up in Yorkshire, people tended to look to America for what was coming next—be it properly functioning showers, disco, or a revival in outmoded economic doctrines. Today, history is moving in the opposite direction, and we can look across the North Atlantic for instruction in what the U.S. economy may soon be facing, especially if the deficit hawks get their way.

Wednesday was budget day in London, and George Osborne, the boy-faced Chancellor of the Exchequer, presented the Tory-Liberal coalition’s economic plans for the next year. The headline-grabbing measure was a cut in gasoline taxes of one penny per liter—about six cents per U.S. gallon. That won’t mean much to British motorists who are already paying more than eight dollars a gallon for “petrol.” (Fuel levies in the U.K. are still much, much higher than they are here.)

The U.K. Treasury billed this as a package for growth, but that was a misnomer. The real news was the revelation that the government has downgraded its forecast for G.D.P. growth in 2011 from 2.1 per cent to 1.7 per cent. Since the previous forecast was only issued in November, this represents a reduction of almost a fifth in just five months. And many independent authorities believe the government is still being too optimistic. The London-based National Institute for Economic Research predicts growth of just 1.5 per cent this year and 1.8 per cent next year. Some pessimists, such as Nouriel Roubini, are warning of a double-dip recession.

Far from reversing the austerity policies he introduced following last year’s election, Osborne reaffirmed them. (Lauren Collins wrote about Cameron’s Big Society plan in October.) While this budget was “fiscally neutral,” meaning it won’t have much impact either way on economic output, the government remains committed, over the next four years, to a swingeing program of spending cuts and tax increases. The sales tax (VAT) has already been raised from 17.5 per cent to twenty per cent. Some government departments are seeing their budgets cut by a quarter, welfare payments are to be cut, and capital expenditures are being postponed. Libraries are closing, and local governments are preparing mass redundancies.

With a budget deficit of more than ten per cent of G.D.P., Britain clearly had to address the public finances. But rather than following the Obama model of introducing a short-term fiscal stimulus to revive growth and tax revenues, Osborne and his boss David Cameron opted for the cut-and-slash policy methods of Andrew Mellon and Philip Snowden—in an effort to balance the budget by 2015. At the time, I and many other observers said that the likely outcome of this absurd exercise in self-flagellation was a sharp dip in growth, and possibly even another recession.

It is a simple matter of arithmetic that when one source of demand in the economy—in this case, the government—cuts back its spending sharply, G.D.P. will fall unless another sector steps up its level of spending. But with Britain suffering from rising fuel prices and a housing bust, there was never much prospect of debt-laden consumers filling the stores or business embarking on an investment binge. Recent statistics confirm that this was wishful thinking. In the fourth quarter of last year, the U.K. economy shrank at an annual rate of more than two per cent: consumer spending and business investment both fell. Most independent experts think the first quarter of this year wasn’t much better.

During the early nineties, a similarly deflationary period, Britain got lucky. Thanks to George Soros, the country crashed out of the European exchange-rate mechanism, the value of the pound collapsed, and exports surged sufficiently to buoy up the entire economy. In 2007 and 2008, it looked like Britain might get fortunate again. In the first months of the financial crisis, sterling tumbled about twenty per cent, and growth revived more quickly than it did in other Western countries. But since the start of 2009, the value of the pound has been rising again, and growth has stalled.

With consumer confidence at a record low and unemployment rising, the British economy badly needs a boost in domestic spending. The obvious way to generate it is to ease off on austerity policies and adopt a more gradual approach to balancing the budget. But Osborne and Cameron have staked their reputation on what was once called “the Treasury View” of public finance—that was before John Maynard Keynes went to work there—and, alarmingly, some people in Washington appear determined to follow their example.

Rather than giving in to the deficit hawks, President Obama should point out what is happening in Britain. Things still aren’t great here—unemployment remains much too high—but the Federal Reserve is forecasting that the U.S. economy will expand by somewhere between 3.4 per cent and 3.9 per cent this year, more than twice as fast as the U.K. economy. To be sure, it would be unwise to attribute all of this divergence in performance to budgetary policy. But it would be far more unwise to assume that what is happening in Britain hasn’t got anything to teach us here in the United States.